The Inside/Outside Pay Gap

Loyalty doesn’t necessarily pay for executives looking to rise to chief financial officer and to earn top dollar when they do.

Compensation consultants and executive recruiters say internally promoted CFOs commonly get a much smaller pay package initially than outsiders hired for the same post, often landing them in the bottom 25% among their peers.

Brian Ajhar

Conversely, a finance chief poached from another company might be awarded a signing bonus and a cash-and-stock package potentially worth millions, as “make whole” compensation for the unvested stock awards he left behind at his former employer.

Such was the case at J.C. Penney Co., which is undergoing a major overhaul under new Chief Executive Ron Johnson, former head of Apple Inc.’s retail stores. In January 2011, the retailer promoted Michael Dastugue to CFO and gave the then 20-year company veteran a base salary of $575,000, well below the $711,250 salary former CFO Robert Cavanaugh got in 2010. As a retention bonus, it gave Mr. Dastugue restricted stock in November, helping to push his reported 2011 compensation to roughly $4.3 million.

Just months later, Penney paid handsomely to attract Kenneth Hannah, who was president of MEMC Electronic Materials Inc.’s solar-energy unit and its former CFO, to replace Mr. Dastugue, who left amid a broader shake-up of the retailer’s business. Mr. Hannah’s base salary is $850,000, and he was given a grant of restricted stock valued at $2.5 million. In addition, he got a $2 million signing bonus “in relinquishment of certain benefits and compensation provided by his previous employer and as an inducement to join the company,” says a Securities and Exchange Commission filing.

Companies often give incoming executives lump stock awards to bring their holdings more in line with those of other executives and with company policy. Penney didn’t respond to requests for comment.

“The big upfront payments are less and less about sign-ons and more about make-wholes,” says Chris Langhoff, founder of CCL Search LLC, a financial-executive search firm. And such payments “get bigger later in the year as an entire year’s bonus has to be covered,” he says.

To be sure, internally promoted CFOs may have never held the post before, and experience is a big factor in executive pay. Mr. Hall says he advises clients to let promoted CFOs know how much their pay can climb over time with good performance.

In addition to losing Mr. Hannah to Penney, MEMC lost its CFO, Mark Murphy, in May to former employer Praxair Inc. A company spokesman called the recent departures “atypical,” adding that MEMC “periodically reviews compensation practices to be competitive with the industry and attract top talent.”

MEMC replaced Mr. Murphy with Brian Wuebbels, a vice president who joined the Missouri-based semiconductor and solar-technology company in 2007. Mr. Wuebbels, who previously worked for General Electric Co. and Honeywell International Inc., says his pay, which includes a salary of $400,000 and a potential cash bonus of up to $600,000, as well as options and restricted stock, is “very fair and quite consistent with my predecessors when they started.”

This summer Mr. Wuebbels also got a performance-based options grant that will vest only if MEMC stock hits certain target prices. He said he hasn’t once checked to see where his pay package stands in comparison to industry peers or similarly qualified CFOs. “It was never part of my thinking to get my due,” he says.

Corporate boards are so risk averse, they sometimes feel that spending more to attract top outside talent is a safer bet than hiring from within, says Randy Ramirez, a compensation consultant with BDO USA LLP. “What boards have to do is a flip-flop,” and consider internal candidates more thoughtfully, he says.

“The world is littered with external hires who got inside and were a monster,” Mr. Hall says. Companies “not only pay a premium [for outside talent],” he adds, they pay sometimes-hefty fees to external recruiters.

Though the pay gap between internally and externally hired CFOs remains, there is anecdotal evidence that a similar gap between inside and outside CEO hires is shrinking, says Mr. Ramirez. He says some recently promoted CEOs have received packages that are much closer to what other, externally hired CEOs have gotten. Take Apple’s Tim Cook, for example. When he was named CEO last year, he was granted a million restricted shares that will vest in equal parts on his fifth and 10th anniversary in the post. If vested and sold now, the grant would be worth nearly $700 million.

Some companies simply have no choice but to hire an outsider. CCL’s Mr. Langhoff says many outside hires go to companies that are struggling or lack the bench to promote from within, “so they may have to pay up for the rights to world-class talent.”

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